Can anyone explain how exactly cheap oil makes the stock market crash? Gas companies do not make up most of the stock market. Cheap energy means cheap everything else. Sense when does cheap energy cause everything else to crash?
I don't think oil is the cause of the market drop: stocks had been overbought for a while (if you look at historic P/E ratios), so it is natural for it to return to normal.
Also, the increasing interest rate is going to put downward pressure on the stock market, even if the economy does well. Right now that is what I consider to be the main cause of the drop. What I mean is:
In the market, there are day-traders, and long-term traders. The day traders are mostly responsible for the day-to-day gyrations of the market, and they've been looking at the price of oil as something to follow. Underneath that, though, the long-term traders have been removing money from the market (leaving it in cash, or switching to bonds), so even after the day traders get done, there is still a net negative.
Of course, that's a simplification for explanation purposes because I don't want to write a book here.
And Norway, and Russia, and probably others.
The economy in Norway looks pretty bad right now. And Russia is having very bad times right now I believe.
At least in Norway it's because the oil price is way to low for them -- I heard that they break-even at $60 or $70 per barrel. That's pretty bad if practically the whole economy is based on oil.
https://www.regjeringen.no/no/aktuelt/the-norwegian-experien...
http://money.cnn.com/interactive/economy/the-cost-to-produce...
Really? The 10-year Treasury yield (the best measure of long-term rates) has declined by 25% since the start of the year. No one is forecasting Fed interest rate hikes in 2016 anymore.
At one point in time (sorry, I forget when) there was a surprising (to some) announcement of QE during which you could observe the result directly. The Fed announced it would buy more long term bonds, and the price of those long term bonds fell.
It is also possible to disturb the equilibrium in one direction while moving it in the other direction. In the example above, the change in equilibrium (higher interest rates) outweighed the disturbance (lower interest rates).
If stocks are overbought, is that an indicator that there's a huge amount of money out there chasing returns? Returns it can't find elsewhere?
A simple example is that of capital gains. Which is "taxed" at a lower percentage (at least in USA) than normal salary/profit income. I would argue that this simple and relatively benign-looking "incentive" is actually a market distortion that has far-reaching consequences.
That's my concern really. Money is running out of places to go.
* stocks (overbought)
* real estate (still recovering from the last failure; already overbought in major markets)
* auto loans (I hear murmurs we're in a subprime auto lending bubble)
* oil (obvious!)
If you're chasing returns, and you can't beat inflation (because you can't find those returns), your cash is slowly becoming worthless. Note my concern isn't because I have cash to invest: its because of the damage that rush of money has as it races into new "investment opportunities".
You still lose purchasing power in a relative sense over time, but limited to about a -1.5% per year for inflation-adjusted gold.
But really, it isn't that difficult to find an inflation-adjusted return better than -1.5%. Even a local family-owned restaurant could probably manage to eke out +0.1% or better just by hiring a part-time professional food-service manager to overhaul the formerly ad-hoc business strategy of mom and pop.
The problem is that many large investors don't even want to bother with thousands of small businesses, because you need to invest in a lot to average out their risk factors, and each of them would require a lot of individual attention to become more profitable. Large-scale investors don't even want to deal with just a single chain restaurant brand like Olive Garden or KFC, so they buy Darden or Yum! instead, because food service is such a low-margin sector overall that you literally need thousands of restaurants in your portfolio in order to be a worthwhile investment to someone that is hands-off.
Small business discovers it is more difficult to find investors with both the money to burn and the time to spend babysitting a relatively small investment. VCs don't want to invest $100k in a small business, restructure it, and then get $200k of value back; they want to invest $10M in a small business, restructure it, and get $100M back. Even if you could somehow bundle up all the locally owned single-location restaurants in the US, divide them up into grades and classes, and resell to investors, it would still be an unpopular place to park money. But if you could instead convince all those restaurants to take out small business loans, and you resell those, you're suddenly rolling in money. Lending is just a better, safer business to invest in than small-time food service.
Real estate prices are well in historical norms compared to rents (http://www.economist.com/blogs/graphicdetail/2015/11/daily-c...)
By what measure are stocks overbought? If we blindly look at earnings, stocks have an earnings yield of about 3% over a 10 year Treasury note, well within accepted ranges (http://www.investopedia.com/terms/e/equityriskpremium.asp)
So, for example, CEO's would prefer their compensation in stocks rather than getting a salary.
It contributes to skew in terms of buying property or capital that'll "appreciate" or get speculated on. Rather than investing in creating a business that'll pay dividends.
Most investment these days is speculation, or the expectation of "increase" in the capital value of the investment. Dividends are practically non-existent, and are a tiny fraction of the "return" you get simple from increased capital value. This, I would argue, gives companies/organizations/corporations the wrong signal. It tells them to optimize for "capital growth" of the stock, because that's what investors want/expect. So that means pumping profits back into the company itself (which requires reducing dividends to token amounts) and aiming for "growth".
To be honest, it'd be difficult to quantify exactly how much the different tax-rates skew the markets. And you have to take it along with the rest of the market distortions. E.g. Retirement annuity tax benefits, or property-ownership tax benefits.
p/e ratios are historically very low relative to interest rates
Even so, it's worrying. It means that oil companies have (collectively) predicted a much higher future demand growth than realized. This suggests that the world's economies aren't growing as quickly as they used to (many fingers are pointed at China), and could spell troubles for other industries who have also invested heavily, anticipating future growth that won't come (so soon).
It's a very ballsy move, but it's also a very dangerous one, because the Saudi regime relies heavily on direct patronage - handouts - and if those stop happening there's a real danger of instability.
It's also very dangerous to poke Russia too hard, because Putin really isn't likely to say "Fine then, I'll just give up."
This could all end very badly for everyone.
So they've decided to fight for market-share this time. And they can, since their production prices are on the low side.
It gets more bizarre though. Putting aside economics, the US, the Saudis and the Iranians all have a pretty aligned geo-political reason for pumping the oil hard: ISIS.
Politics and war make strange bedfellows.
Syria's production is close to Belarus's production and behind Cuba's. And even before its decline it was behind Ukraine's production.
It's not a big enough player for anything. Especially for a juggernaut like Russia.
But so if there's only so many barrels of oil going to be sold, then at this point it really is an all-out scrap for market share. Maybe Saudi Arabia is aiming to just to divest themselves of the majority of their reserves while volumes like that can still be moved at all, i.e., over the next 20-50 years.
If this is a 20 year game then it's time for bold moves.
That might be an over-extension of the markets-as-preditive-tool view. I am more inclined to see the current prices as a consequence of latencies in the oil markets that prevent it from showing true supply and demand accurately. When prices were high, too many new wells were drilled at once because it takes a long time for the new oil to hit the market and bring prices down. When the new oil hits the market and starts reducing the price, none of the producers can cut back on what they send to market because they have to pay off the loans that they used to drill their wells in the first place.
The supply side is structurally unable to respond to demand, regardless of what they predict future demand to be.
Oh look, there's a version you can play online: http://forio.com/simulation/harvard-business-school-root-bee...
The Guardian actually covered that in a short article last month. http://www.theguardian.com/business/2016/jan/21/oil-prices-s...
I know this is very simplistic, and in the end there is probably some reason below all of this... but sometimes, it just doesn't look like it.
At a more complex level, you have a war between US oil producers and OPEC (Organization of the Petroleum Exporting Countries). OPEC wants to put the US oil producers out of business. The US producers have started to give OPEC competition, driving down oil prices. The result has been an oil boom to oil crash. Lots of companies that were hiring are not hiring and in some cases, cutting jobs. Cutting jobs impacts employment numbers, employment numbers affect investments, the fed rate and a whole host of other things.
While the energy sector won't make the market crash by iteself per se, it will certainly drag it down and make investors a lot more skittish to put more money into the market - having the effect we're currently experiencing.
They call this more "fast money" in the mkt. More highly leveraged participants, etc.. Those speculators impact price and generally speaking selling begets more selling and vice-versa - and you get a more volatile market.
It has only been established a recent correlation between equities and oil. There could very well be factors driving both markets in the same direction, or it could be (and most people don't like to accept the concept) a good old-fashioned coincidence.
If the oil prices stay low (which is totally unsure) then it will be beneficial over the course of a few year, but right now the economy is adjusting.
Due to rapid technological advances in shale oil extraction (ie fracking), North American companies have radically changed the daily global supply of oil, which of course puts downward price pressure on it.
Much of the recent price drop can be defined in terms of Saudi's getting into a price war with these NA companies, trying to push them off the market.
Not only that, but this technology is a long-term game changer, ie it will be only a matter of time before all the world oil players (Russia, Venezuela, etc) co-opt this tech and start extracting much cheaper oil from their fields, which of course the markets are anticipating as well.
I have to admit I'm surprised. I totally bought the idea that oil would never be this cheap again for fundamental physical reasons. But perhaps that made it a bubble. A true bubble must have a "story" about how it's "different this time" that manages to convince huge numbers of people.
I recall years ago though reading a debate between a peak oil "doomer" and someone saying climate change was the bigger problem. The latter kept saying we have more oil at higher prices and that the real problem is we have "enough carbon to destroy the world." If we really got desperate and decided we didn't want Florida we could do deep in situ conversion of massive conventionally unreachable reserves of very deep coal into gas ("water gas reaction"), then liquids. That could, he said, keep our liquid based transport economy going for thousands of years but would send Earth back to the Permian.
https://en.wikipedia.org/wiki/Petrodollar_recycling
The idea that the major oil producers earned such a windfall that their money immediately would be sent back to the west in form of investment.
Today I think it is more complex and the low oil price is both a cause and a symptom of something that is mostly not so good.
I believe you wanted "Since when..."
price is a function of supply and demand.
oil prices are low because demand for oil is low
oil is an input into nearly every aspect of the economy
thus low demand for oil could imply low demand for goods for which oil is an input (it could also reveal some kind of major efficiency improvement or the presence of some substitute for oil (or an increase in the supply of oil).